You've probably all heard of the Santa Claus rally - the market's tendency to rise, often on low volume, in the run-up to Christmas. But you may not appreciate how consistent it is. Since 1980, the FTSE All-Share has risen no fewer than 27 times during the month and only fallen six times. True to form, in the past four years the market rallied 1.85 per cent during the month in 2009, 7 per cent in 2010, 1 per cent in 2011 and 0.9 per cent last year.
It's worth noting, too, that the odds are stacked heavily in your favour. During the 27 'up' years since 1980, the average December gain has been 3.17 per cent. Even allowing for the six 'down' years as well, the average monthly gain is about 2 per cent.
Moreover, the chance of taking a big hit during December is much less than at other times of the year. Even during bear markets, the size of December's falls - about 0.5 per cent on average - has been modest. The UK stock market has only been in a bear market four times during December in the past four decades, so any potential hit is unlikely to be that severe. In turn investors become less risk averse and more likely to play the markets.
Reasons for Santa Claus rally
So why does the market gift investors such healthy returns in this way? There are three main reasons:
■ Window dressing. For fund managers chasing bonuses, performance is everything and they seek to maximise it at year-end.
■ Seasonality. The fourth quarter has been a great time to be invested in equities as the UK stock market generally; it has only fallen seven times in the three-month period since 1980, and overall has posted an average gain of 3.8 per cent.
■ Christmas trading. Most of December's outperformance tends to come in the second half of the month. This has everything to do with Christmas falling in the final week of December, which has a direct impact on how markets behave around this time of the year.
Improving the odds of a Happy Christmas
There's a simple reason why December gains are so weighted to the final fortnight: volume. It is common to see trading volumes tail off in the run up to Christmas, as dealers and traders shut up shop for the festive period. As liquidity dries up, the only market participants still trading are likely to be buyers of shares. So conditions are ripe for the market to rise on low volumes - which is exactly what happens.
In the past 31 years, the UK market has risen no fewer than 27 times in the period from 11 December to 5 January, falling only four times. The average gain has been 2.67 per cent, even allowing for the down years.
Like clockwork, the market rose by over 5 per cent over this 25-day period in both 2008 and 2009, 2.3 per cent in 2010, 3.4 per cent in 2011 and 3 per cent last year. Not only is that better than the historical average, but there are also far fewer down days, so the risk of banking a loss on this trade is low. By comparison, historically the odds of the UK market rising in the first 10 days of December are no better than 50:50.
It's also worth noting the influence on stock prices of 'Triple witching' - when quarterly index and stock options and futures derivative contracts are settled on Euronext. This has a noticeable impact on UK equity markets at this time of the year. You don't have to be trading futures and options to see its effects.
Since 1998, the market has risen no fewer than 10 times and only fallen five times across the 10 trading days either side of triple witching day in December (which this year falls on Friday 20 December). It doesn't take rocket science either to understand why this happens because with a seasonal investing tailwind in the fourth quarter, it's only reasonable to assume that most investors holding 'in-the-money' options by the mid-December option expiry date will be long of the market. Therefore, it is in their interest to make sure that these contracts are settled at the highest possible prices, so they tend to bid up the market to ensure this happens.
A year-end rally is even more likely if you consider that the market has risen on average over 75 per cent of the time on the two trading days prior to Christmas and the three trading days following Boxing Day. So, with Christmas Day falling on Wednesday this year, and option expiry the previous Friday, it means that no fewer than 11 of the 15 trading days that fall this year between Wednesday 11 December and Friday 3 January have historically been very strong days. Put like that, would you bet against a Christmas rally?
Jumping the gun
As regular readers of my columns will know, I not only look at historical and seasonal factors when making an investment recommendation, but also take into consideration the macro and general market back drop. Having done so, I have every reason to believe that Santa Claus will pay equity markets a visit this year. Investors will undoubtedly be enticed by the 11 per cent earnings growth expected for the blue chip FTSE 100 index next year, which cuts the earnings multiple down from around 14 times at present to nearer 12.5 times in 2014. That rating is 0.8 points lower than consensus for Europe and almost 2.5 points lower than the forward rating on the S&P 500 for 2014.
It also looks to me that the UK markets are overdue a catch-up with their US cousins which have been powering ahead – the benchmark S&P 500 now trades on 16.5 times 2013 earnings estimates. Interestingly, the drift in the FTSE 100 since the start of November has been very modest and, having unwound from an overbought reading on its 14-day RSI when the price peaked out at 6820, the index appears to be ideally placed for an assault on both that high as well as the May high of 6875. I would be very surprised if this doesn’t happen in December.
I fact, I am so convinced that the markets will sign off 2013 on a high note that I am prepared to jump the gun and go long of the UK index now at around 6668, rather than waiting until the 11 December to initiate the trade. My plan is to run an index trade on the FTSE 100 until Friday 3 January in order to capture all the upside this trade has generated in the past. Please note that the FTSE 100 accounts for a near 75 per cent weighting in the FTSE All-Share so is an accurate proxy of the performance of that index. It is also far easier to trade too.
How to play the trade
Playing this FTSE 100 trade through a spread bet is my preferred option. Profits from spread betting are tax-free in the UK and you can place a bet from as little as £1 per point on movements in the index. Spread-betting providers in the UK include City Index, IG Index, Capital Spreads, CMC Markets and Cantor Index.
Alternatively, if you have access to a CFD trading account you can always gear up an exchange traded fund (ETF) listed on the London Stock Exchange that tracks the performance of the FTSE 100. ETFs include those issued by Lyxor (TIDM: L100), a subsidiary of French investment bank Societe Generale, Deutsche Bank (TIDM: XUKX) and iShares (TIDM: ISF).
Finally, the FTSE 100 index can also be traded through covered warrants. In particular, Societe Generale's FTSE 100 covered call warrant SC30, which has an exercise price of 6600, expiry of 21 March 2014 and a parity of 1000:1. With the index trading at 6668 at 11am on Tuesday, 26 November, the warrants are priced on a tight bid-offer spread of 24.1 to 24.3p, which means that 28 per cent of the warrant price is 'in the money' and the balance is 'out of the money'. The effective leverage of the SC30 call warrants is 14.85 times the movement in the FTSE index. Full details of the warrant can be viewed online at Societe Generale's website: https://sglistedproducts.co.uk
Finally, I have written two columns today, both of which appear on my home page. In response to recent newsflow, I am currently working my way through a large number of updates on the following recommendations: Bezant Resources (BZT), PV Crystalox Solar (PVCS), Crystal Amber (CRS), API (API), Mountview Estates (MTVW), Daejan (DJAN), Bovis Homes (BVS), WH Ireland (WHI), Netcall (NET) and Pilat Media Global (PGB).
MORE FROM SIMON THOMPSON ONLINE...
In the past fortnight I have published articles on the following 16 companies:
■ 32Red ('Hitting the jackpot', 11 Nov 2013)
■ Macau Property opportunities ('Hot property plays', 12 Nov 2013)
■ First Property ('Hot property plays', 12 Nov 2013)
■ Inland ('Bargain shares updates', 12 Nov 2013)
■ Terrace Hill ('Bargain shares updates', 12 Nov 2013)
■ LMS Capital ('LMS worth capitalising on', 15 Nov 2013)
■ Trifast ('A bolt-on purchase', 18 Nov 2013)
■ Global Energy Development ('Awaiting pay dirt', 19 Nov 2013)
■ Entertainment One ('Blue sky territory', 20 Nov 2013)
■ Marwyn Value Investors ('Blue sky territory', 20 Nov 2013)
■ Polo Resources ('Unloved and undervalued', 21 Nov 2013)
■ Heritage Oil ('Bargain shares update', 21 Nov 2013)
■ Eros ('Conundrum to solve', 25 November 2013)
■ Amino Technologies ('Conundrums to solve', 25 November 2013)
■ Town Centre Securities ('Time to make friends up north', 25 November 2013)
■ Raven Russia ('Cash in on a Russian property play', 25 November 2013)
